5 Safe And Cheap Dividend Stocks To Invest (September 2019) (2024)

The markets have been on a roller coaster ride this year. Even though markets have reached for new highs, and the S&P 500 crossed the psychological 3000-mark for the first time in July this year, the volatility has been generally high. In the last few months, the market has been driven mainly by three factors: 1) Fed’s interest-rate policy 2) trade-disputes with China. 3) slowing corporate earnings and global growth or lack thereof.

S&P 500 ETF (SPY) six-month chart, courtesy Yahoo Finance

Irrespective of the market's day-to-day gyrations, we remain on the constant lookout for companies that offer sustainable and growing dividends and maybe trading cheap on a relative basis to the broader market as well as to their respective 52-week highs. We believe in keeping a buy list handy and dry powder ready so that we are able to use the opportunity when the time is right. In addition, we think, every month, this analysis is able to highlight some companies that otherwise would not be on our radar.

This article is part of our monthly series where we scan the entire universe of roughly 7,500 stocks that are listed and traded on the US exchanges, including over-the-counter (OTC) networks. We usually highlight five stocks that may have temporary difficulties and/or lost favor with the market and offering deep discounts on a relative basis. However, that's not the only criteria that we apply. While seeking cheaper valuations, we also demand that the companies have an established business model, solid dividend history, manageable debt, and investment-grade credit rating. Please note that these are not recommendations to buy, but should be considered as a starting point for further research.

We start with a fairly simple goal. We want to shortlist five companies that are large cap, relatively safe, dividend paying, and trading at relatively cheaper valuations in comparison to the broader market. The objective here is to highlight and bring to the notice of value-oriented readers some of the dividend-paying and dividend-growing companies that may be offering juicy dividends due to a temporary decline in their share prices. The excess decline may be due to an industry-wide decline or some kind of one-time setbacks like some negative news coverage or missing quarterly earnings expectations. We adopt a methodical approach to filter down the 7,500-plus companies into a small subset. Also, to select five stocks, we will choose at least two stocks that have high current yields and the remaining ones that have had high dividend growth.

Note: Please notice that when we use the term "safe" regarding stocks, it should be interpreted as "relatively safe" because nothing is absolutely safe in investing. Also, in our opinion, for a well-diversified portfolio, one should have 15-20 stocks at a minimum.

Goals For The Selection Process

We want to emphasize our goals before we get to the actual selection process. Our primary goal is income and the secondary goal is to grow capital. These goals are by and large in alignment with most retirees and income investors as well as DGI investors. A balanced DGI portfolio should keep a mix of high-yield, low-growth stocks along with some high-growth but low-yield stocks. That said, how you mix the two will depend upon your personal situation, including income needs, time horizon, and risk tolerance.

A well-diversified portfolio would normally consist of more than just five stocks and preferably a few stocks from each sector of the economy. However, in this periodic series, we try to shortlist and highlight just five stocks that may fit most income and DGI investors, but at the same time are trading at attractive valuations. However, as always, we recommend you do your due diligence before making any decision on them.

Selection Process

The S&P 500 yields less than 1.90% currently. Since our goal is to find companies for our dividend income portfolio, we should logically look for companies which pay yields that are at least better than the S&P 500. Of course, the higher, the better, but at the same time, we should not try to chase high yield. If we try to filter for dividend stocks paying at least 1.90% or above, there are more than 2,000 such companies trading on US exchanges, including OTC networks. If we further limit our choices to companies which have a market cap of at least $10 billion and daily trading volume in excess of 100,000 shares, the number comes down to about 400 companies.

We also want stocks that are trading at relatively cheaper valuations, so we will apply an additional filter with a forward P/E of no more than 20. However, a P/E of 20 is not really that cheap, so in our quest for not paying too high a price, we add one more criterion that the close price is at least 10% below the 52-week high. After applying these additional criteria, we got a smaller set of about 150 companies.

Criteria to Shortlist

• Market cap >=$10 Billion
• Daily average volume > 100,000
• Dividend yield >= 1.90%
• Dividend growth past five years >= 0%
• Forward P/E <= 20 or trailing P/E <=25
• Distance from 52-week high < -10%

By applying the above criteria, we got roughly 150 companies. The number is still too large to meaningfully present here, so we will narrow down the list further.

Narrowing Down the List

As a first step, we will eliminate stocks that are not part of the CCC list (List of Dividend Champions, Contenders and Challengers created by David Fish and now maintained by Justin Law). The CCC list currently has 887 stocks in all the above three categories, which includes 136 Champions with more than 25 years of dividend increases, 234 Contenders with more than 10 but less than 25 years of dividend increases and 517 Challengers with more than five but less than 10 years of dividend increases. After we apply this filter, we are left with 86 companies on our list.

We also import the various data elements from the CCC list and assign weights based on different criteria as listed below:

• Current yield: Indicates the yield based on the current price.
• Dividend growth history (number of years of dividend growth): This indicates the dividend growth rate during the last five years.
• Payout ratio: This indicates how comfortably the company can pay the dividend from its earnings. This ratio is calculated by dividing the dividend amount per share by the EPS (earnings per share).
• Past five and ten year dividend growth: Even though it's the dividend growth rate from the past, this does tell how fast the company has been able to grow its earnings and dividends in the recent past. The recent past is the best indicator that we have to know what to expect in the next few years.
• EPS growth (mean of previous five years of growth and expected next five years growth): As the earnings of a company grow, more than likely dividends will grow accordingly. We will take into account the previous five years actual EPS growth and the estimated EPS growth for the next five years. We will add the two numbers and assign weights.
• Chowder number: This is a data point that's available in the CCC list. So, what's the Chowder number? This number has been named after well-known SA author Chowder who first coined and popularized this factor. This number is derived by adding the current-yield and the past five years dividend growth rate. A Chowder number of "12" or more ("8" for utilities) is considered good.
• Debt/equity ratio: This ratio will tell us about the debt load of the company in relation to the company's equity. We all know that too much debt can lead to major problems, even for well-known companies. Lower this ratio, better it is. Sometimes, we find this ratio to be negative or unavailable, even for well-known companies. This can happen for a myriad of reasons and not always a reason for concern. This is why we use this ratio in combination with the debt/asset ratio (covered next).
• Debt/asset ratio: This data is not available in the CCC list, but we add it to the table. The reason we will add this because, for some companies, the debt/equity ratio is not a reliable indicator.
• S&P's credit rating: Again, this data is not available in the CCC list, and we will add manually. We get it from the S&P website.
• PEG ratio: This also is called the price/earnings-to-growth ratio. The PEG ratio is considered to be an indicator if the stock is overvalued, undervalued, or fair priced. A lower PEG may indicate that a stock is undervalued. However, PEG for a company may differ significantly from one reported source to another, depending on which growth estimate is used in the calculation. Some use past growth, while others may use future expected growth. We are taking the PEG from the CCC list. The CCC list defines it as the price/earnings ratio divided by the five-year estimated growth rate.
• Distance from 52-week high: We want to select companies that are good companies but also trading at cheaper valuations currently. They may be cheaper due to some temporary down cycle or some combination of bad news or simply had a bad quarter. This criterion will help bring such companies (with a cheaper valuation) near the top, as long as they excel in other criteria as well.

Below is the table (presented in two parts) with the list of 86 companies with weights assigned to each of the 10 criteria. The first table shows the raw data for each criterion, whereas the second table shows the weights for each criterion and the total weight. Please note that both tables are sorted on the total weight.

Table 1A:

Table-1B:

This second table shows the weights for each criterion and the total weight.

Selection of the Final 10

To select our final 10 companies, we will follow a three-step process:

Step1:

We will first take the top five names in the above table (on the basis of total weight).

Table 2A:

Step 2:

Now, we will take the top 15 (on the basis of total weight) and sort the list on the basis of dividend yield (highest at the top). We will take the top 5 after the sort to the final list.

Table-2B:

Step 2C:

Now, we will take the top 15 (on the basis of total weight) and sort the list on the basis of five-year dividend growth (highest at the top). We will take the top 5 after the sort to the final list.

Table-2C:

From the above three steps, we have a total of 15 names in our final consideration. After removing duplicates, we are left with 10 names (VLO appears three times, PRU appears twice). We also remove MPC as it's similar to VLO and BEN as it is similar to PRU. The final list of 10 stocks is as follows: TABLE-3:

Final Step: Narrowing Down to Just Five Companies

This final step is not really all that important. The reason is this step will be a subjective one and based solely on our perception. The readers could select any of the above 10 names according to their own choosing or as many as they like. However, if we only had five spots to fill, and that was our goal, we would select the following. One overriding factor was to select at least a couple of companies with a high current yield. The readers could differ with the selections, and they may come up with their own set of five companies. Here's what we selected:

Final List:

• PRU
• ADM
• VLO
• MMM
• LYB

It goes without saying that each company comes with certain risks and concerns. Sometimes these risks are real, but other times, they may be a bit overblown and temporary.

Nonetheless, we think these five companies would form a solid group of dividend companies that would be appealing to income-seeking conservative investors, including retirees and near retirees. Our final list of five has at least five years of dividend history, better than investment-grade debt rating, and trading on an average of 30% discount from their 52-week highs. Their average dividend/income (as a group) is very attractive at 4.57%, which is nearly 45% higher than what it was at the beginning of the last year. Though we selected only five stocks based on several criteria, however, there are many other stocks on our extended list that may be equally appealing.

Below is a snapshot of five companies showing their current discount and dividend yield compared to the beginning of last year, i.e., January 2018.

Table-4A:

Table-4B:

Conclusion

At the beginning of January 2018, the average dividend yield of these five stocks was 3.16%. During the course of last year, all five of these companies have raised their dividend payouts. Also, stock prices of the five companies have fallen, some of them significantly, meaning their current yields are much higher. If you were to buy these five companies today and invest equal amounts, you would get roughly a 4.57% dividend, which is about 45% higher over what it was at the beginning of last year. Price wise, they are on an average 30% below their 52-week highs. We believe that not much has changed with regard to the fundamentals or the quality of these companies, yet we are being offered a much higher dividend payout. So we think that this group makes an excellent watch list for further research.